Two days ago, natural gas (UNG) plunged more than 6%. Partly, natural gas suffered from the updates coming from EIA. The plunge started with the weekly storage report, and continued with the weekly update.
In this article, I'll go through the good and the bad that these reports brought. I'll start with the bad.
Seemingly, the market didn't like the weekly storage report. The inventory build came in at +62 Bcf. This brought natural gas a bit closer to normalcy, as the usual build for this week is around 80-100 Bcf, yet the market immediately sold off on the number. Apparently, the market was gunning for a 56 Bcf build and felt disappointed. I will just add that this 62 Bcf build keeps natural gas in a healthy trajectory for natural gas to hit around 3800-3850 Bcf storage at the peak, as long as we get a normal summer.
Although most of the negative effect on natural gas happened with the storage report, there was still a bit of bad news coming later. That was the weekly update, which showed that in this latest week, natural gas usage to generate power went up by just 3.3% from last year, and dropped 10% from the week before. This was a genuine bad number, and perhaps what the market was anticipating all along, given the recent very unfavorable weather, which has kept temperatures at their lousiest possible points (for power generation). This does point towards a somewhat unfavorable storage build next week, and that might have been the reason why the market traded so weakly.
As I said, the weekly storage number is still within a trajectory which will lead to natural gas not exceeding or even threatening to exceed the storage capacity. Meanwhile, the market still trades as if storage filling up is not only a possibility, but a near certainty.
Also, from the weekly update, we can see that supply is getting closer and closer to 2011's numbers (+2.69% year-on-year), and showing weekly drops (-1.28%). This points towards the reduced number of rigs and natural production drop already starting to have an effect. This is hugely positive for natural gas, as this effect will steepen over time.
At the same time, while demand for power generation was broadly affected by the unfavorable temperatures, these did help some other demand components, namely, commercial and residential. These demand components allowed overall demand not to drop too much in the week (-2.41%) and kept demand growing briskly year-over-year (+5.85%). Granted, this was less than we have been observing, but one should remember this happened under unfavorable conditions.
Also importantly, the market continued to focus on how much higher than normal inventories are, compared to the year-ago levels as well as the 5-year average. In my article Natural Gas Storage Fears And Realities, though, I show that this excess over normalcy is much smaller than it looks.
Natural gas continues to trade as if storage will not normalize before the peak of the injection cycle. Yet, every week, the injections are coming in well below 2011 levels, due both to increased demand (up to this week, driven by higher demand for power generation) and stagnated supply, which is even showing some signs of an outright decline.
Given these developments, I continue to believe that natural gas will be going up both during the remainder of 2012, and for other reasons (production drop-off, less drilling), more strongly during 2013.
While I believe natural gas will head up, I am not necessarily positive on shale-focused natural gas producers like Chesapeake (CHK), Southwestern Energy (SWN) or Quicksilver Resources (KWK). The reason why I am not so fond of these companies is tied with the reason I believe natural gas will head up eventually: because shale wells quickly see very large production drops, and it will be these companies that will suffer from those production drops, as I also expect them to be the ones doing less drilling. I still expect some of the major beneficiaries of a higher natural gas price to be companies that generate power from other sources, companies such as Exelon (EXC) or Public Service Enterprise Group (PEG).
Disclosure: I am long (EXC).